U.S Crackdowns On Chinese IPOs Over Use Of 'Shell Companies', Stops Processing Registration Of IPOs Till New Regulatory Framework Is Set Up

The Securities and Exchange Commission (SEC), the corporate and market regulator of U.S, has launched a crackdown on Chinese companies barring them from going public in the U.S. unless they make new risk disclosures.

The SEC will stop processing registrations of U.S. initial public offerings (IPOs) and other sales of securities by Chinese companies while it formulates a new set of guidance for disclosing to investors the risk of a new regulatory crackdown by Beijing, Reuters reported.

"In a number of sectors in China, companies are not allowed to have foreign ownership and cannot directly list on exchanges outside of China. To raise money on such exchanges, many China-based operating companies are structured as Variable Interest Entities (VIEs)." SEC chair Gary Gensler said in a statement.

“I worry that average investors may not realise that they hold stock in a shell company rather than a China-based operating company,” Gensler said.

"A China-based operating company typically establishes an offshore shell company in another jurisdiction, such as the Cayman Islands, to issue stock to public shareholders. That shell company enters into service and other contracts with the China-based operating company, then issues shares on a foreign exchange, like the New York Stock Exchange. While the shell company has no equity ownership in the China-based operating company, for accounting purposes the shell company is able to consolidate the operating company into its financial statements." Gensler said.

Gensler said that the shell company based arrangement creates “exposure” to the China-based operating company, though only through a series of service contracts and other contracts.

Neither the investors in the shell company’s stock, nor the offshore shell company itself, has stock ownership in the China-based operating company, Gensler added.

"In light of the recent developments in China and the overall risks with the China-based VIE structure, I have asked staff to seek certain disclosures from offshore issuers associated with China-based operating companies before their registration statements will be declared effective." Gensler said.

SEC commissioner Allison Lee said earlier this week that Chinese companies listed on U.S. stock exchanges must disclose to investors the risks of the Chinese government interfering in their businesses as part of their regular reporting obligations.

The SEC‘s move comes amid increasing pressure from US lawmakers, who have passed legislation such as the Holding Foreign Companies Accountable Act as a way to force Chinese companies to improve disclosure standards.

U.S investors were taken by surprise as Chinese regulators launched crackdown on the country’s tech and education sectors this month because of concerns about cybersecurity, personal data management and monopolistic practices.

Beijing also said it has been working to close the loophole Chinese companies use by setting up offshore VIEs to list abroad.